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7 Reasons Investors Should Embrace Inflation

Bye, bye Ben. Inflation may cause rappers to quit singing about Benjamins in favor of Clevelands since Grover Cleveland is on the $1000 bill.

Inflation has always been viewed as a consequence of poor economic policies or planning. Never do we hear of it being seen as an instrument of deliberate economic policy. This is about to change.

The reasons inflation carries such a negative label are many, prime of which are that it is a tax on wealth and people with wealth generally govern, but not always. We know from experience that liberal politicians see nothing wrong with the haves supporting the have-nots. Government is their preferred vehicle for forcing this process to occur (most haves prefer charitable giving.)

Government tries to get the haves to relinquish a fair share (an amount well above biblical guidelines, but otherwise undefined) of their earnings through high tax rates. However, since you cannot always get tax rates high enough to meet your spending plans without also damaging the economy, you tax wealth through planned inflation. It would be naïve to think that this alternative has not occurred to our politicians or to believe they are not actively pursuing such a policy. After all, it’s a policy that can be implemented in secret, with no votes taken or even admission that this is what’s taking place. While inflation does not itself redistribute wealth, it does put more money into the hands of those who see themselves as the wise arbiters of who should have how much. For them, far be it to hand such an important goal to the anonymous ‘market’ to make such important decisions. A good way to start would be to begin massive spending during a crisis ( a word defined today as ‘a terrible thing to waste’.)

What then are inflation’s virtues?

Government tax revenue based on income, property values and sales will all take gigantic leaps as inflation kicks in.

Government spending will lag the inflation rate creating a surplus which is needed to service the huge debts incurred and, over time, increase the capacity to take on new debt. This cheapening of debt effect is also true for the trillions of dollars in unfunded mandates such as social security, health care and government pensions. How often did you read or hear the term ‘trillion dollars’ before 2007?

Inflation also cheapens the purchasing power of the debt held by foreign governments, namely China, who must eventually spend their trillions in dollar reserves on goods, services or investments other than debt. In short, inflation puts a time pressure on them to use these reserves in a more productive way.

The current housing and mortgage crisis will be remedied much quicker with high inflation. The unsold housing inventory will be bought up as an inflation hedge. Mortgage holders will be less inclined to default since their houses are now appreciating assets. New home construction will restart, stimulating an important economic driver.

Economic growth, in nominal terms, would make our reported statistics look like China’s or Brazil’s. Underlying growth would probably improve as well since complacency in the private sector will lead to failure by the least efficient as survival means you have to run faster to stay even. Likewise, many bad investments made during prosperous times will be bailed out by inflation since the value of their output can now show nominal profits. Sales and output will rise as consumers scramble to buy today what they know will cost more tomorrow.

Corporate profits and stock prices will rise as reported double digit growth rates make the haves feel like inflation is not so bad after all. If inflation is accompanied by dollar devaluation, so much the better. With most of our large companies doing a large share of their selling abroad, currency accounting profits only add to the joy.

While inflation is disruptive, it has the virtue that those it doesn’t kill it makes stronger. It is the instrument for moving resources from the hands of the weak to those which are strong. It punishes inherited as well as earned wealth poorly employed.

For a liberal politician, all this is nirvana. My best scenario for 2011 is that by mid-year, the Fed will be finished with its QE2 program for taking the banks and others out of their carry trade positions at below free-market yields (dare I use the words ‘bailout 2’). This means long term rates will now be free to rise based on free market forces. Then, as banks redirect the capital previously employed in the carry trade into commercial loans, economic growth will increase, but the velocity of money will also rise. It is this increase in velocity that drives inflation, and Mr. Bernanke has said he wants to see more inflation. In short, don’t fight the Fed.

Next month I will write in my newsletter about what’s wrong with this picture but meanwhile, position your portfolios in expectation that serious inflation will happen.

Richard Lehman is a Forbes columnist and publisher of the Forbes/Lehmann Income Securities Advisor newsletter. Click here for more details on Forbes Income Securities Investor

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